GET READY, GET SET
What you need to know before starting a nonprofit
Peter B. Manzo and Alice Espey
Copyright 2001, Center for Nonprofit Management
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in
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intended use is for commercial purposes or for financial gain.
This book may be reproduced through photocopying and transmitted in its original PDF format
for purposes of freely sharing information contained therein, and not for any financial gain nor
for any commercial purposes.
ISBN: 1-892233-03-7
First printing December 2001
Updated August 2002
Updated June 2004
The information in this book is provided without warranty, based upon personal experience,
research, and findings. Neither the author nor the Center for Nonprofit Management shall have
any liability to any person or entity with respect to any liability, loss or damage caused or alleged
to be caused directly or indirectly by information contained in this book. If legal advice or other
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Published by:
Center for Nonprofit Management
606 South Olive Street, Suite 2450
Los Angeles, CA 90014
Tel: 213-623-7080
Fax: 213-623-7460
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www.cnmsocal.org
GET READY
GET SET
What you need to know
before starting a nonprofit
Peter B. Manzo and Alice Espey
with Nora Burton and Snow Tempest
A project of the California Management Assistance Partnership
Published by the Center for Nonprofit Management
Preface
T
his book was written as a project of the California Management Assistance Partnership
(C-MAP), an informal collaboration of nonprofit organizations that provide management
information, training, and consulting services to nonprofit organizations throughout California.
Along with our C-MAP partners, we were compelled to write this book because we hear from
literally thousands of callers each year who ask, “How do I start a nonprofit organization?” This is, in
fact, the most frequent question we receive. Many of the people we talk with do not fully understand
what is needed to build a successful nonprofit organization and what they must do to comply with
the laws and regulations that apply to nonprofit organizations. This understanding is critical to the
success of a new organization. We also receive hundreds of questions each year from groups that have
started a nonprofit organization but are not sure what to do next. They are struggling to raise funds
and attract supporters, and partly as a result, they do not have sufficient time or resources to build
the organization. We often encourage them to consider how much more quickly and effectively they
might accomplish their goals if they could find another way to put their passion and energy to work
on their causes, rather than spend so much effort creating a new nonprofit organization.
This book is not intended as a guide to starting a nonprofit organization. Several other good
publications do that, and we will tell you about them when we get to implementation steps. Instead,
we address a question that we ask you to consider first: “Is creating a new nonprofit organization the
best way to accomplish your objectives?” We want you to successfully reach your goal. Sometimes
the best way to do this is to start a nonprofit organization; more often it is not. If, after reading this,
you decide that starting a new nonprofit organization is indeed the best course, we want you to be
ready for the challenges ahead. (In the latter sections of this booklet, we relent and outline the steps
involved in establishing a new nonprofit organization.)
The many individuals who have shared their dreams with us have shaped this publication. Your
experience will help us improve it. Please feel free to send your comments to your local C-MAP
partner. To locate the partner near you, visit www.c-map.org or our Nonprofit Genie Web site,
www.genie.org. We wish you well in your efforts to improve your community. Please let us know if
our work has helped you and how we can improve upon it.
Acknowledgments
M
any thanks to our California Management Assistance Partnership partner organizations
and their Information and Referral staff, and particularly to: Linda Brady of the Center
for Nonprofit Management for her research and suggestions; Sara Roscoe Wilson, Alice
Lowe, and Lee Schneider of Nonprofit Management Solutions in San Diego; Beverly Braun of the
Nonprofit Support Center in Santa Barbara; Judy Ross of the Long Beach Nonprofit Partnership; William Staley, Esq., of Arter & Hadden for his insightful legal review; The California Endowment for its
generous support; and to all the managers, staff, and volunteers of fledgling or established nonprofit
organizations whose questions and comments helped shape this resource.
This book is a successor to an earlier booklet, also titled “Get Ready, Get Set,” published by the
Center for Nonprofit Management. That book was written by Patty Oertel and William Ramseyer;
we are indebted to them, especially to Patty, who recognized the need for a guide for those seeking
information about forming a new nonprofit organization.
Table of Contents
Preface
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ii
Working for the public good is serious business
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Key characteristics of nonprofit organizations . .
Planning is essential . . . . . . . . . .
Reasons not to start a new nonprofit organization
Decision tree for launching a nonprofit organization
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14
16
17
17
18
23
SECTION 1:
PREPARING WELL TO DO GOOD
SECTION 2:
THE LEGAL FRAMEWORK
Tax exemption for public benefit nonprofits . . . . . . . . . . . . .
Incorporation and alternatives . . . . . . . . . . . . . . . . . . . . .
Advantages of incorporation and tax exemption . . . . . . . . . . .
What is a nonprofit corporation? . . . . . . . . . . . . . . . . . . .
How nonprofit organizations work . . . . . . . . . . . . . . . . . .
You can do it: Incorporating should be affordable and fairly painless
SECTION 3:
RESOURCES
Publications . . . . . . . . . . . . . . . . . . . . . . . 25
Internet resources
. . . . . . . . . . . . . . . . . . . . 26
Organizations . . . . . . . . . . . . . . . . . . . . . . 26
vi
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Get Ready, Get Set
1
Get Ready, Get Set
Preparing Well
To Do Good
T
1
Working for the public good
is serious business
he nonprofit sector is larger and more influential than many people realize.
Most people would be surprised to learn that in the United States, nonprofit
organizations contribute 8% of the Gross Domestic Product, employ 10% of
the workforce, and generate approximately $750 billion in annual revenues. In 1998,
California’s public charities reported total revenue of more than $68 billion.
Nonprofit organizations provide medical care, education at the preschool
through university levels, museum exhibits and arts performances, health and
athletic facilities and programs, child care, workforce training and education,
counseling, food and shelter, housing, economic development, and much more.
Funding for charitable endeavors is precious and
increasingly scarce, and the needs those dollars serve are
crucial to the health and well being of countless individuals
What we mean by
and communities. As a result, these charitable funds and
“nonprofit organization”
the activities they support demand the highest level of
stewardship. Further, nonprofit organizations face many
of the same challenges that for-profit companies confront
Throughout this booklet, we use the term
(such as controlling quality, managing and motivating
“nonprofit organization” to refer to groups
personnel, attracting investors/donors), but they typically do
whose purposes are to benefit the public
so with far fewer resources than their for-profit counterparts.
and which are exempt from income tax
Finally, nonprofit organizations differ substantially from
under Sections 501(c)(3) or 501(c)(4) of
for-profit enterprises in many critical respects, so
the federal Internal Revenue Code. (In
management solutions and strategies that succeed with
actuality, there are more than 20 categories
for-profit enterprises cannot simply be applied to nonprofit
of tax-exempt organizations under Section
organizations; indeed, nonprofit organizations encounter
501 of the federal tax code, all of which
many unique challenges. It should be clear, then, that
are “nonprofit” organizations, so, while the
starting a nonprofit organization requires just as much
term “nonprofit” is imprecise, we try to use
planning as launching a for-profit business enterprise, if
not more.
it in the way most people commonly use
it.)
Most important, while in some ways nonprofit
organizations are very similar to for-profit enterprises,
nonprofits face moral and ethical issues that do not come
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Get Ready, Get Set
into play with for-profit enterprises. Perhaps the preeminent rule is similar to the
Hippocratic oath that doctors take: First, do no harm. Nonprofit organizations
deal with many of the most sensitive, personal and difficult problems, from
child abuse, mental health, or chemical dependency on a human services scale,
to important issues such as civil rights or environmental protection. While the
nonprofit sector is, and should be, a rich source of innovative approaches to
important challenges, it is not simply a space in which to “let a thousand flowers
bloom.” Any experimental approaches should be grounded in a careful review of
the best known practices. If you go forward without careful consideration, you run
a high risk of failure that may poison the well for others trying to address the same
issues, not to mention hurting the very people or issues you seek to support.
Nonprofit directors, officers, and managers are also bound by the following
simple ethical rule: You must be faithful to the public good above your personal
interests. This is not only an ethical duty, but also a legal duty that can be enforced
under the law.
Accordingly, a nonprofit organization should only be created to serve an
important public purpose, and only after careful consideration of (1) whether
forming a new organization is the best vehicle for accomplishing that purpose and
(2) whether you and your supporters are prepared to form this new organization.
W
Key characteristics
of nonprofit organizations
e have found that certain characteristics best help individuals clarify
whether a nonprofit organization is the appropriate vehicle for their
goals. These concern purpose, ownership, control, and accountability.
We describe these essential characteristics here so you can consider them before
continuing.
Purpose
If the world seems cold to you,
kindle fires to warm it.
- Lucy Larcum
The term “nonprofit” does not mean the organization cannot make a profit. In
fact, in order to survive nonprofit organizations must have a surplus of revenues
over expenses. The term “nonprofit” is used because a nonprofit organization is set
up not for the purpose of making a profit, but for pursuing public benefit purposes
recognized under federal and state law—for example, an educational, scientific,
literary, or charitable purpose.
What makes an organization “nonprofit” is that:
l the mission of the organization is to undertake activities whose goal is
not primarily to earn a profit;
l no person owns shares of the corporation or interests in its property;
and
l the property and any income of the corporation are not distributed to
any “owners,” but instead are recycled into the corporation’s public
benefit mission and activities.
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Get Ready, Get Set
Ownership
A nonprofit organization, in a sense, is “owned” by the public. No private
person can claim ownership or control of the organization. The assets of a nonprofit
organization are irrevocably dedicated to charitable, educational, literary, scientific,
or religious purposes. That means the nonprofit’s cash, equipment, and other
property cannot be given to anyone or used for anyone’s private benefit without
fair market compensation to the organization. Moreover, a nonprofit’s property is
permanently to be used for exempt purposes. When and if the organization decides
to dissolve, any assets remaining after the debts and liabilities are paid must go
to another nonprofit organization—not to members of the former organization or
other private individuals.
Control
Control of a nonprofit organization is vested in a governing board of directors
or trustees. The board’s responsibility is to see that the organization fulfills its
purpose. To this end, the board makes final decisions regarding the direction and
staffing of the organization. Board members do not act as individuals, but must act
as a group. No one should be guaranteed permanent tenure on a board, and the
board may decide it is necessary to fire an executive or to remove board members.
This means that no one person, not even the founder, can control a nonprofit
organization. Board members should be supporters of the organization who donate
their time and money to its purpose. Under California law, fewer than half of
the members of the board of directors of a public benefit nonprofit can be paid
employees or officers, or related to other persons who are paid employees or
officers.
Accountability
The California Attorney General
Nonprofit & For-Profit Comparison
has power to oversee the operations
of public benefit corporations and can
Nonprofit
For-profit
even step in and take a corporation
Public Benefit
Maximize revenues and
to court to make sure it complies Purpose
value to shareholders
with the law. Nonprofit organizations
are accountable to the public and Ownership
Community
Shareholders
must file annual information returns
"stakeholders"
with federal and state governments.
Purchase of shares
Donations, Grants,
Sources of
These returns report the financial
by Investors
Contracts, Borrowed funds
Revenue
operations of nonprofit organizations,
Earned
revenues from
Earned revenue from
services and products
including the salaries of the five (5)
services and products
Borrowed funds
highest paid non-officer employees.
Internal Revenue Service
Securities & Exchange
IRS Form 990 Information Returns Regulation
Commission
State
Attorney
General
are public information. Nonprofits
Shareholders - Stock Market
must make these returns available to
members of the public who request
copies, and copies are also available on the Web from the California Attorney
General’s Registrar of Charitable Trusts (http://caag.state.ca.us/charities/) and
private websites (for example, www.guidestar.org).
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Get Ready, Get Set
Planning is essential
P
eople who are passionate about a cause are very eager to get started. If you
feel tempted to incorporate an organization and seek tax exemption as your
first steps, we ask you to pause first and fully investigate the feasibility of
launching and sustaining a new organization.
It is accepted wisdom, especially in the business world, that those who fail
to plan, plan to fail. Unfortunately, some people who would never start a forprofit venture without first gaining some experience in the field,
crafting a business plan, and hesitating for a long time before
Is this you?
asking their family and friends to invest, fail to apply
Put your passion
the same logic to starting a nonprofit organization.
As competitive as the for-profit world is, it is even
into planning
harder in many ways to develop a successful
Many people who feel strongly about a cause also
nonprofit organization, and the stakes for our
feel without sufficient study or planning, that they
communities are much higher. A failed business
already know what programs they will need to operate.
affects primarily the owners and investors.
They realize that they will need resources to accomplish
In contrast, a failed or marginally successful
their goals, and that they will need tax-exempt status in order
nonprofit organization wastes scarce charitable
to raise funds from foundations and individuals. Therefore,
resources that could be used to serve those
they conclude that the first thing to do is to form a nonprofit
in need. Further, a poorly managed nonprofit
corporation and apply for tax exemption. Unfortunately, this
organization
reflects poorly on the entire
approach puts the cart before the horse. In reality, the organinonprofit community and affects the ability
zation’s chances of receiving tax exemption and then conof other nonprofit organizations to gather
vincing donors to fund its projects will depend on how
support.
the group addresses the planning steps described in this
section. Keep in mind that if you are truly passionate about an issue, the best thing you can do is
to make sure you do the best possible job
in addressing it, and that will take
strong planning.
B
Reasons not to start
a new nonprofit organization
efore discussing how to decide whether you should form a new nonprofit
organization, it may be worthwhile to describe some reasons that should
not lead to the formation of a new charitable organization.
You have a time-limited special project that will benefit your
community (e.g., building a swimming pool, sponsoring
an art exhibit).
Though these projects may well have a public benefit purpose, there are
more practical and effective ways to accomplish these goals than creating
a new organization. Review the section on alternative structures on page
16 if you have this type of goal.
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Get Ready, Get Set
You wish to support a needy individual (a sick child, a
family in distress).
Nonprofit organizations cannot have as their purpose the benefit of specific individuals. Nonprofits that provide human services must do so for an
entire class of people. Besides, most people who are motivated to give to
help specific people, whether someone they know or someone they learned
about on the news, give regardless of whether their gift is tax deductible—or they give to a nonprofit organization that helps people in similar
situations. It’s fine to “pass the hat” and to explore existing resources in
the community.
You think a lot of grant money will be available.
Most nonprofits survive with diverse sources of support, of which
grants are often a small percentage. Most financial support comes from
individuals. Further, grants are not easy to come by. Funders usually look
for broad community support and an established track record in organizations they consider funding, and many foundations do not fund on a
multi-year basis. The table below shows the reality of grant funding in the
nonprofit sector.
We haven’t got the money, so
we’ve got to think!
- Ernest Rutherford
1871-1937 in Bulletin
of the Institute of
Physics (1962)
1999 Contributions to the Nonprofit Sector
Corporations (6%)
Bequests (8%)
Foundations (10%)
Individuals (76%)
(1999 Contributions to the Nonprofit Sector: $190.16 Billion, By Source of Contribution
Source: Giving USA 2000/ AARFC Trust for Philanthropy)
You have a service or product you want to provide below
cost or donate, but want a tax deduction.
Business owners, professionals such as dentists or lawyers, and other
people with special skills often want to provide their services, or distribute their products below cost or for free, and are interested in getting a
tax deduction for their contributions. The simple answer is that generally,
though your motives may be altruistic, donating goods or services does not
merit forming a new nonprofit organization.
If you want to donate a good or service, you might find it best to volunteer with or contribute to an existing tax-exempt organization, which you
do not control. In that case, you may be able to deduct the value (on cost)
of goods donated or expenses associated with your services (e.g., cost of
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You cannot be a leader, and ask
other people to follow you, unless
you know how to follow, too.
- Sam Rayburn
Get Ready, Get Set
materials for pro bono dental work, but not the value of dental fees). The
reasons for this are as follows: (1) Donations of goods are only deductible
as charitable contributions if given to a qualifying organization exempt
from tax under IRC Section 501(c)(3) (i.e., a religious, charitable, educational, literary, or scientific organization); and (2) The value of donated
services is not tax deductible. (For more information on what donations
qualify for tax deductions, see IRS Publication 526, “Charitable Contributions,” at www.irs.gov.)
In some situations, people want to seek grants or donations to compensate them for providing services to people who otherwise may not be
able to afford them. Sometimes this would be a sideline of the service
provider’s primary business. This also is not a valid reason to create a nonprofit organization. The IRS frowns on this because of the likelihood that
charitable funds will be used to benefit the private business and its owners.
If you want to use your skills for disadvantaged people free or below cost,
either volunteer with or do paid work part-time for an existing tax-exempt
organization.
Accordingly, if you are providing professional services free or below
cost, you cannot claim a tax deduction for the value of the services. (In the
view of the IRS and state tax agencies, you are not entitled to a tax deduction for revenue you do not earn. This rule may not seem to encourage pro
bono work by professionals, but that is the law.) If you are giving away a
product free or below its value, you may be able to get a tax deduction for
a charitable contribution if you provide the gifts to or through a tax-exempt
charitable organization. If you want to distribute the product to people yourself, however, you will not be able to claim a charitable gift deduction.
You feel your current work is not meaningful.
Separate your career goals from the formation of a new organization.
Finding meaningful work is a very important and commendable goal, but
that alone will not justify starting a new organization. There are many
attractive career opportunities with existing nonprofit organizations. Contact your local C-MAP partner for suggestions on how to conduct a job
search in your area.
You have important knowledge and perspectives to
share.
Think carefully about whether an organization is really needed. There
may be more effective ways to get the word out, such as writing a book,
speaking in public, or teaching.
You want to do things your own way and not be fettered by
rules and bureaucratic procedures.
The hope that nonprofits offer such freedom is usually an illusion. As you
will see, nonprofit organizations must be governed by a board of directors exercising their independent judgment about the best interests of the
organization. If the board functions properly, this greatly diminishes the
control any one person, even the founder, has over the organization. Further, as already mentioned, the Internal Revenue Service and foundation
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Get Ready, Get Set
and government grantmakers all demand that an organization show that it
receives broad public support. Finally, nonprofit organizations are held to a
higher standard than for-profit businesses in terms of broad public disclosure and reporting requirements and are subject to broad oversight by the
IRS and the California Attorney General.
I
Decision tree for
launching a nonprofit organization
n this section we present a set of questions to help you explore whether forming
a new nonprofit organization is the best way for you to accomplish your goal.
As you address these questions, you will:
l Verify, define, and detail the need or opportunity you want to address
l Identify alternative ways to accomplish your goal
l Analyze and evaluate each alternative
l Choose the best alternative
l Re-test this alternative
l Implement your decision
People make decisions in different ways. You may not want to take on these
questions in exactly the order in which we have presented them. Feel free to tackle
first the question that seems most pertinent. Before you start a new organization,
however, you need to be able to answer “yes” to each question. If you do, then
you will be ready to form a new organization and can be confident that you can
explain to potential supporters and donors why it was necessary to create a new
organization (and they will ask).
To give alms is nothing
unless you give thought
also.
- John Ruskin
Questions
* Is your proposed project something a nonprofit organization
can legally do?
* Is there a demonstrated need for your project?
* Can you clearly state your mission?
* Have you carefully considered a partnership with an
existing organization?
* Can you describe what success would look like?
* Can you describe how you will pursue your goal (the steps
to success)?
* Will others (foundation and government grantmakers,
individual donors, board members, and volunteers) commit
time and resources to your cause?
* Do you and your supporters have the skills to start the
proposed new organization?
Is your proposed project something a tax-exempt
organization can legally do?
We discuss acceptable purposes under Section 501(c)(3) further below,
on page 14. As we have already mentioned, nonprofit organizations
exempt from tax under Section 501(c)(3) must pursue a public
benefit purpose. Accordingly, Section 501(c)(3) organizations cannot,
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Life’s most persistent and urgent
question is, “What are you doing
for others?”
- Martin Luther King, Jr.
Get Ready, Get Set
among other things, (1) be operated for someone’s private benefit, (2) support or oppose a political party or candidates for office or (3) have as the mission of the organization the achievement of something only possible by the
passage of legislation. Note that running a business without paying income
tax is never an acceptable purpose for a nonprofit organization, either as
a legal or ethical matter.
Can you demonstrate that the need or opportunity
exists?
People start nonprofit organizations because they believe there is an
opportunity to make a positive change or to enrich the quality of life. You
probably see this need or opportunity very clearly. To raise the resources
and support you’ll need to be successful, you’ll need to prove that you are
right. Groups concerned with an issue often create an initial list of problems or needs based on their personal experience and observation alone.
You need to gather good data and survey the opinions of others involved
in your issue in the community to verify that the need or opportunity
exists. Nonprofit organizations deal with vulnerable populations and difficult, sensitive issues from domestic violence to civil rights to the environment. Dealing with these issues is serious
business, and people who work in the nonprofit sector must be skilled and compe“Facts are simple and facts are straight
tent.
Facts are lazy and facts are late
You need a broad understanding of
Facts all come with points of view
your field and a detailed understanding of
Facts don’t do what I want them to.”
the specific situation that concerns you.
“Crosseyed and Painless,” Talking Heads
Before you begin your research, take an
hour to sketch out, just for yourself, the
Quantitative information refers to statistics and numeric comparineed you have identified and how you plan
sons. For example, you may need to create a community profile
to address it. This will help you identify
by age, gender, crime rate, housing, income, education, cultural
the questions you need to answer and the
facilities, or employment and compare this to the situation in a
information you want to gather.
broader region. Government agencies gather and make available a
First, be sure you have a good general
great deal of statistical information, much of it now available on
understanding of your field. Magazine and
the Internet. Learn what federal, state and local government agenjournal articles can be an excellent introcies are involved in your area of interest and what they have availduction. If you are not sure where to start,
able. Explore the information your United Way, other nonprofit
go to your local library and ask the librarian
organizations, and local universities have gathered. For sources of
for assistance. Read everything you can on
data, refer to the resources listed at the back of this book.
the topic. Learn what has been tried, what
does or does not work. Get to know people
Qualitative information includes the opinions and experiences of
who work in the field. Seek them out, disknowledgeable and involved people. The most critical step is to
cuss your idea, and listen to their reactions.
meet with leaders and members of the community you wish to
Often they can provide you with valuable
serve. These viewpoints and this leadership, not the opinions of
insights to develop your plan.
outsiders, must drive your project. Gather their opinions and reacUse this background to study your spetions to your project. Are they interested in your issue? Are they
cific situation. Compile both quantitative
willing to help? Also discuss your project with nonprofit organizaand qualitative information. You don’t need
tions and other groups working in the area. Might you be most
to be a statistician or trained researcher to
effective by working with an existing program?
accomplish this. A great deal of information is available through public sources.
California Management Assistance Partnership
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Get Ready, Get Set
Sit down with everything you have gathered. Prepare your case.
Review your original draft and back up each argument with facts. Then
ask, “Have I demonstrated that the need exists?”
This may seem like a lot of work, but it will not be wasted. If you start
a nonprofit organization, you will need this statement of the conditions
you are trying to change (your “case statement”) for every proposal you
write to a foundation, and to approach potential donors or recruit board
members, employees and volunteers. Also, in the process of doing the
research, you will meet people with whom you may want to collaborate in
the future.
Mission is the star we steer
by. Everything begins with
mission, everything flows
from mission. It is solely why
we do what we do.
- Frances Hesselbein
Can you clearly state your mission?
It is important to be able to define clearly the mission the organization
will pursue. A mission statement should be short (suggested maximum of
three simple sentences) and should quickly and clearly convey to readers
the organization’s purpose.
A mission statement should include:
l Why? The purpose or essence of the organization; the change that
will occur because of its existence.
l What? A brief description of the services provided by the
organization that lead to the change or impact.
l Whom? The target population served by the organization.
l Who? The staff and/or volunteers that deliver the service-outlining
any distinctive characteristics.
l Where? The geographic parameters that define your service area.
l How? The method by which the services are delivered.
The mission statement serves multiple audiences. Internally, it provides
the focus and momentum for all activities within the organization. The
mission statement also provides outsiders (funding sources, community
members and constituents) with a concise statement about the organization, from which they can determine if they want to develop a relationship
with your program.
A mistake that many groups make is to reduce their mission statement
to the “betterment of humanity.” While no one disagrees that this is a
worthy goal, it is not specific enough to describe your true mission. By
providing specific information on the organization’s purpose, you help
potential donors and volunteers to make an informed decision about
whether to support your cause.
As the organization grows, you should monitor progress against those
goals and objectives.
If you have built castles in the
air, your work need not be
lost; that is where they should
be. Now put foundations under
them.
- Henry David Thoreau
Can you describe what success would look like?
Develop with your supporters a clear vision of what the world will look
like if your program succeeds. What difference will your program make?
If you cannot articulate a clear, compelling vision of your goal, you are not
ready to begin a new organization. Prospective supporters will want a clear
vision of where you are going, and of how you plan to get there.
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Get Ready, Get Set
Can you describe how you will pursue your goal?
I have no plans, and no plans
to plan.
- Mario Cuomo, Governor of NY, on presidential
ambitions, NY Times 14
Sep 86
With your project vision in mind, create a clearly articulated statement
of your purpose that others can understand. Then outline your plan to
achieve this mission. Write out specific targets and outcomes you will use
to measure your success in reaching each goal. Describe specific steps to
accomplish each goal. How much time will each step take? What people,
space, equipment, time, and money will it require? This plan should
broadly map the future of your organization. If you need guidance on how
to create a plan, consult your local C-MAP partner or other local management support organization, or consult one of the books in the bibliography
at the back of this book.
You may not know every detail at the start; one purpose of this plan is
to identify areas that need more research. It is best to work on this plan
with your supporters. The group that has participated in the plan will be
much more likely to provide future support, and the plan will be enriched
by everyone’s best ideas. If you start a nonprofit organization, some of
these supporters will probably serve on your board, and will be responsible for helping guide the organization in following the plan. Keep in
mind that you will need a budget, mission, and plan in order to complete
the paperwork necessary to set up a nonprofit organization, as well as to
request funding from foundations, government agencies, and individuals.
Will others commit time and resources to your cause?
During their early years, nonprofit organizations most frequently rely on the support of individuals who give their
time and money to the cause. This is similar to small
Potential sources of
business start-ups, in which entrepreneurs often
income:
get funds from friends and relatives. Groups
Nonprofit organizations have a range of opporwho found successful nonprofit organizatunities for financial support. Donations, grants, and
tions often work very hard during the
non-cash assistance (also called in-kind contributions)
early years for little or no financial commay come from such diverse sources as government agenpensation. This brings home the point
cies, corporations, foundations, federated campaigns (such as
that nonprofit organizations are not
United Way), churches, local businesses, fraternal or social clubs,
solo crusades. Can you identify indior individuals. In addition, nonprofit organizations can earn revviduals who will support your orgaenue from charging reasonable fees for the services or products they
nization in this way?
provide in pursuit of their public benefit mission.
Support from individuals is espeDepending on the source, assistance may include general operating
cially critical to new organizations.
funds, program-specific funds or non-cash assistance.
As
we pointed out earlier, even estab* General operating funds are given to a nonprofit organization
lished
organizations rely heavily on
without any restriction on how the funds should be expended.
donations
from individual supporters.
* Program-specific or restricted funds are granted for restricted use
It is a common misconception that founon a specific activity sponsored by the nonprofit organization.
dation
and government grantmakers will
* Non-cash assistance (also called in-kind contributions)
donate
money
to cover the costs of starting
is an alternative to cash support, and assumes a range
a nonprofit organization. In fact, instances
of forms, including donation or loan of facilities,
of
this type of funding are rare. Grantmakers
personnel, products and services, or technireceive
many requests for support. They look for
cal assistance.
an established track record and clear evidence that
the organization has a broad base of support.
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Do you and your supporters have the skills best suited to
starting the proposed new organization?
Starting a nonprofit organization is demanding. Running an organization requires sound management and administrative skills. You need
to know how to handle money, supervise others, and comply with all
necessary laws and regulations. Few people have all the abilities necessary to grow an organization—but
those who succeed know how to idenA word about human resources
tify and involve a team of people who
To conduct the operations of your organization,
together possess the necessary balance
you will need to rely on people: the board of directors
of viewpoints and skills.
and staff members, who may be volunteer or paid. For
The ability to inspire others to get
more information about the roles of board members, see
involved is crucial. You must want to
pages 18-21.
work with others for the success of
Assess what your organization requires in terms
the organization. Perhaps most imporof human resources (personnel) to deliver your
tant, ask yourself if your commitment
organization’s services, raise money, and provide
to the cause is greater than your peradministrative support. The assessment should focus on
sonal need to run the organization. If
your needs today, in six months, and a year from now.
the organization grows, and you no
In each of these areas (service delivery,
longer have the right set of skills, will
administrative
support, and fundraising), you must
you be willing to accept that it is time
consider what is needed to provide the service or
for you to move on in order to advance
function, what kinds of skills, expertise and licenses are
the cause?
necessary, when the service has to be provided, whether
there are geographic considerations, and whether the
function could be performed by volunteers.
Based on this analysis, you can develop job
descriptions or position statements. Next, you should
determine whether the task must be done by paid staff
or could be done by a skilled, semi-skilled, or unskilled
volunteer. Would a part-time staff person suffice? Is this
task a project assignment, a short-term assignment, or
an ongoing need?
Have you carefully considered a partnership with an
existing organization?
By now you should have encountered other nonprofit organizations
that are working on your issue in your geographic area. If you are unsure
how to locate such organizations, ask your local C-MAP partner, community foundation, United Way, or other local resource for suggestions. Get
to know these organizations and their programs well. They are potential
partners in your work.
Now comes the hardest part. Ask yourself if, in fact, no one else is
working effectively on the issue. Is there truly an unmet need? Confront
this question squarely. Suppress the desire to wriggle out of it because
others are not doing exactly what you would like, or in the way that you
would like. Can you join forces with another group? Nonprofit organizations attract fiercely independent people, which is good, but creating
As they say, “None of us is
as smart as all of us.” That
is good because the problems we face are too complex to be solved by any
one person or any one discipline.
- Warren Bennis
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change is hard. You’ll need allies. If there is already an organization that
has a good board of directors and an established funding base, is there a
clear reason to form another one? Could you work with an existing organization as a staff member, board member, volunteer, or donor? If you ask an
organization with similar objectives to take on your project and you bring
enthusiasm and a source of funds, you probably will be well received. You
will need to fit into the existing organization (board of directors, officers,
committees, budget cycle, etc.), but you will be saved the delay, expense
and energy diversion of establishing a new organization, and you will
probably benefit from the experience and connections of the other group.
If you do decide to start a new organization, will you be able to make a
compelling case for grantmakers and other donors to fund the new organization and to divert funding dollars away from existing organizations serving the same or similar purposes? Charitable dollars are scarce. Are they
best spent starting a new organization, or should they be used to strengthen
an existing one?
Giving should be entered in
just the same careful way as
investing . . . Giving is investing.
- John D. Rockefeller
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Get Ready, Get Set
2
The Legal
Framework
I
f you have gone through the decision steps described in Chapter 1 and decided
that it is best to form a new, independent nonprofit organization, you will need
to prepare to choose a legal form for your organization and seek tax exemption. In the following pages, we will try to give you a basic introduction to the
issues involved in (1) determining whether your organization will be eligible for
tax exemption, and (2) selecting an appropriate form of legal entity.
In reading this outline, please keep the following in mind. When most people
use the term “nonprofit organization,” they typically combine three separate and
distinct characteristics:
l formal corporate status;
l nonprofit character; and
l tax exemption
As a result, many people assume that, for instance, forming a nonprofit
corporation is the only way to obtain exemption from income taxes for their
project or group, or that exemption from tax follows automatically from filing
corporate papers. Neither is true. So, as you read about obtaining tax exemption
and choosing a nonprofit legal structure, remember that a project or group can be
nonprofit, yet be unincorporated, and that whether or not a group is exempt from
tax is a matter of obtaining a tax-exemption designation from the federal and state
tax authorities, regardless of the group’s corporate status.
Above all remember, as we noted above, the purpose of this book is not to
instruct you on how to actually set up a nonprofit organization. To do that, we
strongly urge you either to seek help from an attorney or to follow one of the selfhelp guides we recommend in the back of this book.
Back in the East you
can’t do much without
the right papers, but with
the right papers you can
do anything. They believe
in papers. Papers are
power.
- Tom Stoppard
1937- : Neutral
Ground (1983)
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Tax exemption for
public benefit nonprofits
T
he preferred form of tax exemption is exemption under Section 501(c)(3)
of the Internal Revenue Code (IRC). This is reserved for groups performing public benefit activities and refraining from significant political activism. Organizations exempt under Section 501(c)(3) do not pay income taxes,
and donors to such corporations can deduct their contributions from their taxable
income. Nonprofit organizations engaging in substantial lobbying or legislative
advocacy can be exempt under IRC Section 501(c)(4) from paying tax on what
they take in, but their donors cannot deduct contributions from their taxable
income.
We will very briefly discuss exempt purposes under Section 501(c)(3),
followed by a short description of exempt purposes under Section 501(c)(4).
Section 501(c)(3) tax-exempt purposes:
It’s all papers and forms, the
entire Civil Service is like a
fortress made of papers, forms,
and red tape.
- Alexander Ostrovsky,
The Diary of a Scoundrel,
1868
In a nutshell, tax-exempt status under Section 501(c)(3) is available to
organizations whose purposes are:
§
charitable (as the IRS defines this, which is not necessarily our
common sense of the term)
§ religious
§ educational
§ scientific
§ literary
§ testing for public safety
§ fostering national or international amateur athletic competition
§ preventing cruelty to children or animals
We will briefly go into further detail about charitable and educational purposes,
as most groups we encounter fall into these broad categories.
1. Charitable purposes:
Broadly defined, “charitable purposes” means activities beneficial to the public
interest and serving an open class of people, not a limited number of identified
people. Examples of charitable purposes include:
§ relieving the poor, distressed or underprivileged;
§ advancing education or science (distinct from providing instruction,
which would be an educational purpose);
§ erecting or maintaining public buildings, monuments or works;
§ lessening the burdens of government;
§ eliminating prejudice and discrimination;
§ promoting and developing the arts; or
§ defending human and civil rights secured by law.
For example, organizations pursuing community development, which can
include job training, economic development, developing affordable housing, and
so on, may qualify for exemption under one or more of the following: relieving
the poor and distressed, combating community deterioration and/or eliminating
discrimination, and lessening the burdens of government.
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2. Educational purposes:
The IRS defines “educational” more narrowly than we might expect.
“Educational” in this context means instruction of individuals or the public for
the purposes of improving or developing their capacities. Other education-related
purposes generally must qualify under the broader notion of charitable purposes
described above. (For example, a group providing community health education
would qualify as charitable, rather than educational.) The IRS allows a curriculum
to present particular viewpoints if there “is sufficiently full and fair exposition
of pertinent facts to permit an individual or the public to form an independent
opinion or conclusion.” However, mere presentation of unsupported opinion is not
considered educational. Some examples of educational purposes include:
§ publishing public interest educational materials;
§ conducting public discussion groups, forums, panels, lectures,
workshops, etc.;
§ offering a correspondence course or one that uses other media such as
television or radio;
§ operating a museum, zoo, planetarium, symphony orchestra,
performance group, etc.;
§ publishing educational newsletters, pamphlets, books or other
material;
§ operating a college bookstore, alumni association or athletic
organization for the benefit of, and controlled by, an educational
institution.
For a full discussion of the requirements
for exemption under Sections 501(c)(3),
Section 501(c)(4) Tax-exemption for social
501(c)(4) and other tax exemptions, see
welfare organizations
IRS Publication 557, “Tax-Exempt Status
Another category of tax-exempt, charitable organization
for Your Organization.” (Believe it or not,
includes
social welfare organizations or civic leagues. These
this IRS publication is fairly accessible
organizations receive slightly different tax treatment than
and well written.) You can download it
Section 501(c)(3) organizations because their activities are
from the Web at www.irs.gov/formspubs/
directed more toward influencing public opinion and the
index.html. The IRS web site also has a
legislative process. Tax exemption is offered to such groups
resource page called “Tax Information for
under IRC Section 501(c)(4) if they have educational,
Charities and Other Non-Profits,” which
charitable, or recreational purposes and “operate primarily to
can be found at www.irs.gov/charities/
further (in some way) the common good and general welfare
index.html.
of the people of the community (such as by bringing about
civic betterment and social improvements).” Often the feature
that characterizes an organization as exempt under Section
501(c)(4), rather than Section 501(c)(3), is the degree to which
the organization pursues changes in public policy.
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T
Incorporation and alternatives
here are three basic ways to structure an independent charitable organization under current California law. Your organization may form an unincorporated association, a trust, or a nonprofit corporation. A fourth option
would be to “incubate” a new program under a fiscal sponsor (further described in
the “Alternatives to Incorporation” box below).
An unincorporated association may fit the needs of a small organization whose
activities do not pose liability concerns and that is not required to file applications
Alternatives to incorporation
You do not necessarily need to form a nonprofit corporation to pursue a new project’s
program and fundraising activities. You may be able to operate periodic, short-term activities,
such as an annual car wash or bake sale, without forming an organization. For other small
projects, forming an unincorporated association may be appropriate. For more involved projects
in which there may be a greater need for liability protection and accountability, you can
consider collaboration with an existing organization or fiscal sponsorship.
Unincorporated association
For small or short-term projects, an alternative is to form an unincorporated association.
An incorporated association is simply a group of two or more people sharing a common goal.
Groups often choose to be unincorporated associations if they are only going to be in operation
for a short period. Unincorporated associations are informal and easy to organize. If a program
would qualify by the nature of its service for tax-exempt status and its annual gross revenue is
less than $5,000, then the organization may proceed as if it were tax-exempt without filing an
exemption application with the IRS, and can provide contributors with tax deductions for their
contributions. If it is necessary to obtain an exemption, however, the organization might as well
form a corporation, since it will have to apply for tax exemption anyway.
The primary disadvantages of unincorporated associations are: (1) in certain circumstances,
directors and members may be held personally liable as individuals not only for their own
actions or omissions but also those of other directors and members; and (2) the law governing
unincorporated associations is not as clear as that for nonprofit corporations; unincorporated
associations are dealt with indirectly through the law governing mutual benefit membership
organizations. Despite these disadvantages, an unincorporated association may fit the needs of
small organizations pursuing exempt purposes that are not required to file applications for tax
exemption because their annual revenues are less than $5,000 and whose activities do not pose
liability concerns.
Fiscal sponsorship (“Incubators”)
Some nonprofit organizations are willing to serve as fiscal sponsors for new projects whose
goals are similar to the sponsoring organizations. Further, some organizations provide such
support as a core feature of their charitable mission, serving as “incubators” providing a
supportive environment to nonprofit organizations during their initial stages of development.
In addition to vouching for the public benefit, tax-exempt nature of the project, these
organizations also provide services including planning, financial management, personnel and
legal assistance.
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for tax exemption because its annual revenues are less than $5,000. (See the inset
box “Alternatives to incorporation” for a further description of unincorporated
associations.)
A “trust” is designed to hold assets for a specific purpose, but the restrictions on
a trust’s activities and the duties and potential liabilities of trustees are significantly
greater than for directors and officers of California nonprofit corporations.
For most nonprofit groups based in California, the best legal structure is the
California nonprofit corporation. Nonprofit corporations offer the advantage of
limited personal liability for directors and officers, and the law governing nonprofit
corporations is clear, providing well-defined rules for public benefit, mutual benefit
and religious organizations.
C
Advantages of incorporation
and tax exemption
orporate and tax-exempt status offer public benefit nonprofit corporations
some important benefits, including:
l Limited Liability: A primary advantage of forming a corporation (or
coming under the fiscal sponsorship of one) is that corporations offer
the protection of limited liability to corporate directors and officers.
This is especially important if the organization will be taking in
and expending significant sums of money, buying property, hiring
employees, or entering into leases and contracts. What limited liability
means is that the organization’s directors and officers have limited
personal liability for business debts. Creditors can only go after
corporate assets and insurance to satisfy liabilities incurred by the
corporation.
l Exemption from Income Tax: If the corporation satisfies federal and
state requirements, the corporation will not have to pay income taxes.
This will be discussed more extensively below.
l Contributions Are Tax Deductible: If there are other private persons
or entities that want to contribute to your 501(c) 3 organization, they
may deduct contributions from their taxable income, so they do not
pay taxes on what they give you. This is a great tool for encouraging
contributions.
A
It takes a noble man to
plant a seed for a tree that
will someday give shade to
people he may never meet.
- David Trueblood
What is a nonprofit corporation?
nonprofit corporation is one that is organized and operated for one of the
nonprofit purposes recognized under state corporation law. What makes a
corporation nonprofit is that:
l the mission of the corporation is to undertake activities whose goal is
not primarily to earn a profit;
l no person owns shares of the corporation or interests in its property; and
l the property and any income of the corporation are not distributed to
any owners, but instead are recycled into the corporation’s activities.
(See “Key characteristics of nonprofit organizations” on page 2.)
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What is a corporation?
A corporation is an imaginary thing, a “legal
fiction.” (For example, a company like General
Motors is really nothing but a collection of
people consisting of shareholders, who are the
owners, directors, and officers who control it,
and employees, and the legal rights and duties
that tie them together.) A corporation is treated
as legally separate from the people who own,
manage and operate it. The corporation is able
to enter into contracts and incur debts, and must
pay taxes like any person. The corporation’s
rights and obligations are separate from those
of the people who own or run the corporation.
In other words, if the corporation were to lose
a lawsuit, the people who work there, manage,
or own it would typically not be personally
financially accountable, with some exceptions.
N
California recognizes three types of nonprofit
corporations. They are public benefit, mutual benefit
(benefiting members only), and religious. Since our purpose
here is to assist in the creation of groups intended to
promote public benefit purposes, we will discuss only
public benefit nonprofit corporations.
Examples of groups with public benefit purposes include
childcare centers, shelters for the homeless, community
health care clinics, museums, hospitals, schools, performing
arts groups, conservation groups, and low-income housing
groups, to name a few. We will discuss various definitions
of public benefit purposes further in the next section.
How nonprofit organizations work
onprofit organizations are creatures of state corporate law and are subject
to federal and state tax law. The law in each area imposes duties on
nonprofit organizations and their managers and directors, which we will
describe briefly below.
Oversight by Attorney General
and Internal Revenue Service
Because charitable corporations are supposed to serve public ends, the
Attorney General of the State of California is given broad jurisdiction to supervise
public benefit corporations. The Attorney General may investigate public benefit
corporations at any time to see whether they have departed from their charitable
purposes. Further, public benefit corporations must notify the Attorney General of
the sale or transfer of all or substantially all of the corporation’s assets, a decision
to dissolve, or other important events.
The federal Internal Revenue Service and the state Franchise Tax Board each
have the authority to withhold or remove an organization’s tax exemption and
impose penalties on the organization and its directors and managers. Loss of tax
exemption, while not certain doom, is difficult to overcome.
Governance by Boards of Directors
Under California law, directors bear all legal authority and responsibility
for governing a nonprofit organization (“The buck stops here,” in President
Truman’s words). While it is rare, board members of California nonprofit public
benefit corporations can be held personally liable for breach of their duties to the
corporation and to third parties, as described below. Careful attention to the legal
standard of care will help board members avoid liability.
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To meet the legal standard of care, directors must act:
l in good faith in what they believe to be the best interests of the
organization, (“the duty of loyalty”);
l with such care, including reasonable inquiry, as an ordinarily prudent
person would use in similar circumstances, (the “duty of care”).
While these duties sound stringent, the law does not expect perfect decisions.
Directors and managers are protected by a “Business Judgment Rule,” which holds
that directors and managers cannot be held liable for poor decisions, even if their
decisions hurt the organization, if they meet the following criteria:
l meet the standard of care (“prudent person” or “care appropriate to the
circumstances”);
l reasonably and in good faith rely on information from officers,
employees or professionals; and
l follow the proper procedure for approving any transaction between the
nonprofit and its directors.
The purpose of this rule, both for standard business corporations and nonprofits,
is to relieve directors of the fear of being second-guessed by courts. Directors
should be required to make carefully considered decisions, but not to have perfect
foresight.
Directors, of course, also owe a duty of care to third parties to avoid injuring
people or property through their decisions. This duty arises when directors become
aware, or should be aware, of a situation in which it is foreseeable that someone
may be hurt. If the directors then fail to take reasonable steps to prevent that
foreseeable harm, they may be liable if the harm results. For example, if directors
of a childcare center know that the roof is failing, they must either fix it or
find another site for the children. Another example might be the duty to take
reasonable steps to investigate allegations of sexual harassment or employment
discrimination.
When do any of us ever do
enough?
- Barbara Jordan
Governance by group decision
By law, boards of directors must act as a group. Decisions must be made not by
individual directors, but by the whole board or a committee of the board authorized
to act on behalf of the board on the matter in question. Boards generally make
decisions using either a majority vote (51% of the board members present at a
meeting assuming quorum has been established), consensus, or fluctuate between
these modes. How boards make decisions is in many ways determined by the
profile of the group and the organization’s culture and values.
Roles and responsibilities of directors and managers
It is often said, “Boards make policy, and management implements policy.”
Unfortunately, such statements confuse more than they explain, primarily because
they do not illustrate the difference between a policy decision appropriate for the
board of directors and a choice of implementation options appropriate for the
executive director and management.
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While individual organizations may define these roles differently, the most
common separation of roles would be something like this:
Responsibility
Board of Directors
Executive Director
or Officers
n Exercises fiduciary role to
ensure that the organization
is properly managed. The
Board should have a mechanism to validate information
from the Executive Director.
n Maintains corporate status;
ensures that proper paperwork
is submitted to governmental
agencies.
n Reviews financial and business dealings to protect the
organization from lapsing into
private foundation status and
exercises proper judgment in
self-dealing transactions.
n Must provide information to
the Board to demonstrate
that the organization is well
managed.
n Compiles information for
annual filing requirements.
Signals if either of these
situations is likely to occur.
Finance/
Accounting
n Approves annual budget.
n Reviews periodic financial
reports (balance sheet,
income statement, changes in
financial position).
n Ensures that proper internal
controls are in place.
n Prepares annual budget with
input from staff and accounting department (depending
on size of organization).
n Oversees preparation of
periodic financial reports.
n Implements proper financial
controls.
Planning
n Establishes mission and
program direction for organization.
n Reviews program plan and
progress. Conducts or reviews
program evaluation plan.
n Develops specific program
goals and objectives based
on the board-specified
mission.
n Develops reports or oversees staff development of
reports to demonstrate
program progress.
Policy
n Sets policy.
n Implements policy (the
specific operational decisions
are the staff’s responsibility).
Personnel
n Elects officers
n Hires Executive Director/
Officer and evaluates
performance.
n Reviews personnel policies.
n Implements personnel policies.
n Hires all other personnel
and evaluates performance
of staff members (or delegates
to appropriate supervisor).
Resource
Development
n Establishes fundraising
goals and participates in fundraising efforts.
n Determines feasibility of
fundraising goals.
n May conduct research and
assist in fundraising goals.
n Directs staff assistance with
fundraising efforts.
Board
Governance
n Oversees maintenance of
minutes, attendance records,
and deals with board
members who have lapsed
in responsibilities
n Recruits new board
members (in non-membership
corporations)
n Office staff may assist with
preparation and distribution
of minutes.
n May suggest names for
consideration.
Legal
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Board composition
How big should the board be?
Most nonprofit organizations have discovered that a board size of 5 to
18 members provides a cross-section of skills and expertise, yet still is
manageable. This number of directors can offer broad community representation and expertise for the organization.
The ideal size of the board will depend on the specific needs of your
organization. The board should be large enough to obtain broad-based
community support and input, yet small enough to be efficient.
Should employees be board members?
Although California law allows employees to serve as board members,
in practice, nonprofit organizations rarely have employees on the board,
with the possible exception of the executive director. Having an employee
on the board is not recommended. It increases the potential for conflicts of
interest. Perhaps most important, it may interfere with the board’s ability
to oversee and evaluate the chief executive’s performance. Also, because
the executive director reports to the board, having employees who report
to the executive director also serve on the board can confuse the lines of
decision-making within the organization.
There are other ways for board members to work with and receive
information from employees. Employees can serve on board committees,
attend joint board and staff retreats, and contribute to the evaluation of the
executive director. Many funders (including certain government departments, United Ways, and many foundations) will not fund organizations
that have employees serving as board members.
Should board members be paid?
Although it is legal in California for board members to be paid reasonable compensation for their service, board members of nonprofits usually
serve as volunteers. In fact, the growing trend is for board members to
make personal financial contributions to the organization on whose board
they are serving. Under California law, it is legal for up to 49% of a nonprofit public benefit organization’s board to also serve the same organization as employees or contractors. For example, if there are five directors
on a board, no more than two can receive payment as an officer, employee
,or provider of professional services, such as an attorney or accountant.
Board members can receive reimbursement of reasonable expenses, such
as travel, for their board service.
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Reporting and Disclosure Requirements
Contrary to many people’s perceptions, nonprofit organizations are subject to
extensive reporting and disclosure requirements, in some cases well beyond those
imposed on for-profit enterprises (except in the area of securities regulation, which
typically does not affect charitable organizations). The following is an outline of
the key reporting requirements:
Federal Corporate Tax Returns: Form 990
A nonprofit corporation with tax-exempt status must file annual returns on IRS Form 990
within four and a half months following the close of its fiscal year. Certain organizations are
exempt from this filing requirement, including churches and organizations (other than
private foundations) that normally have gross receipts below $25,000.
Secretary of State Filing and Reporting Requirements
1) California nonprofit public benefit corporations must file an annual Statement by Domestic Nonprofit Corporation, containing the names and addresses of its chief executive officer,
secretary, and chief financial officer; the street address of its principal California office;
and designation of the person authorized to receive official notices for the corporation.
Incomprehensible jargon is
the hallmark of a profession.
- Kingman Brewster,
U.S. Ambassador to
Britain
2) In the event of amendment to the articles of incorporation, or an election to merge or
dissolve the corporation, a nonprofit must file a certificate of the resolution of the board to
take such action, attested to by the secretary of the corporation.
Reports to the Attorney General
1) Nonprofit public benefit organizations, other than religious organizations, hospitals, or
private schools, with revenues or assets over $25,000 must file:
a) an annual RRF-1 notice ($25 filing fee), and
b) a copy of their informational tax return to the IRS (IRS Form 990, 990-EZ or 990 PF)
with the Attorney General’s Registrar of Charitable Trusts no later than four months and
fifteen days after the end of the organization’s fiscal year. The franchise tax exemption of
any charitable corporation may be disallowed for any year for which it fails to file a report.
2) Any major change in the form of the corporation (e.g., a merger or a disposition of
substantial assets) not in the usual course of the corporation’s activities requires a written
notice 20 days in advance of such an event.
State Tax Returns - California Franchise Tax Board Form 199
California nonprofits, other than religious groups and organizations (other than private
foundations) with annual gross receipts normally less than $25,000 are required to file
Form 199.
Public Inspections
All organizations exempt under IRC Section 501(c)3 or 501(c)4, including private
foundations, must make available upon request, by mail or via the Internet, the following
documents:
1) copies of the exemption application (Form 1023) submitted to the IRS;
2) copies of the three most recent informational returns to the IRS (Form 990); and
3) papers submitted in support of these documents (the names and addresses of donors
need not be disclosed).
The organization may post copies of these materials on the Internet, rather than mailing
copies within 30 days of request, so long as the materials are widely available; that is, the
organization tells people requesting these materials or visiting the organization’s Web site
where to find the materials on the Internet (such as on their own Web site or a public
database like Guidestar (www.guidestar.org)), and the materials may be downloaded free
of charge.
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Y
You can do it: Incorporating should be
affordable and fairly painless
ou can perform all the legal work of forming a nonprofit corporation yourself, or you can seek the help of an attorney. Seeking help from an attorney experienced in representing nonprofit organizations may well save
you much time and potential frustration. If you cannot afford an attorney and do
not feel comfortable incorporating the organization yourself, contact your nearest
management support organization, such as the C-MAP partners listed in this booklet, for referral to a pro bono or legal aid organization that may be able to help
you.
Regardless of whether you do it yourself or use an attorney, we strongly
recommend that you look at a copy of How to Form a Nonprofit Corporation
in California or The California Nonprofit Corporation Kit, both published by
Nolo Press and written by Anthony Mancuso, Esq. You should be able to find
either or both of these at your library, at a good local or online bookstore, or at
www.nolo.com. The book or kit will take you step-by-step through the process
of forming a nonprofit corporation and applying for tax-exempt status. Even if
you’re going to have an attorney do the work for you, reviewing these materials
will give you a much better understanding of the process than our short overview.
Following the guidelines in the book or kit also may reduce your legal fees by
saving time you otherwise would be charged for asking basic questions of the
attorney or having them prepare supporting materials you could prepare yourself.
Consult your tax attorney or accountant for further information on federal
and state tax issues and state corporate law requirements.
What is success? I think it
is a mixture of having a flair
for the thing that you are
doing; knowing that it is not
enough, that you have got to
have hard work and a certain
sense of purpose.
-Margaret Thatcher
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Steps to incorporation and tax exemption*
1. (Optional) Clear and reserve, if desired, the name of the corporation with the Secretary of State’s
office.
2. Draft the articles of incorporation and file them with the Secretary of State’s office. The articles
of incorporation announce the formation of the corporation and give its broad purposes.
3. Draft and adopt bylaws for the corporation. Generally, the bylaws are the “constitution” of
the organization. They set out the ground rules and operating procedures for the activities and
conduct of the corporation. Actions taken in violation of the bylaws also may be declared invalid
or challenged, which could hurt the organization. It is very important for organizations to comply
with their bylaws in order to protect their corporate status and the limitation of liability that
comes with it.
4. At the first meeting of the board, the directors must approve certain activities necessary to set up
and run the nonprofit’ s operations, and must give specified people (“officers”) the authority to do
those things. For example, the directors should:
• Accept their election as directors (if they did not already do so when the articles were filed);
• Approve the bylaws;
• Elect officers to run the corporation’s day-to-day operations;
• Authorize officers to prepare and present to the board a budget, and to seek federal and state tax
exemption (if this has not yet been done);
• Authorize officers to set up bank accounts for the corporation to purchase insurance, lease office
space, etc.;
• Create a committee of the board to research and recommend to the board appropriate compensation amounts (wages or salary) for the officers;
• Adopt a policy regarding conflicts of interest, if not already included in the bylaws;
• Determine the exact location of the principal office; and
• Ratify steps previously taken by organizers to create the corporation and pursue tax exemption.
5. Create a minutes book in which you will keep the minutes of your Board of Directors’ meetings,
and enclose copies of the bylaws, articles of incorporation and the minutes of the board’s first
meeting. (The minutes book can be a form book obtained at an office supply store, or even a
simple three-ringed binder; the important thing is to keep records of meetings and important
decisions where you will be able to find them.)
6. Apply for federal tax exemption under IRC Section 501(c)(3) or 501(c)(4), using IRS Form
1023 for 501(c)(3) exemption or Form 1024 for 501(c)(4) exemption. Visit the IRS Website at
http://www.irs.gov to download a copy, or call the IRS at 1-800-829-3676 to obtain the form.
7. Apply for California franchise tax exemption, using FTB Form 3500. You can download or order
the forms from the Web at http://www.ftb.ca.gov. If you have any questions, call the California
Franchise Tax Board at (800) 852-5711.
Accomplishing all these steps can take from two to nine months or more (especially depending
on how long the IRS and California Franchise Tax Board take to review your applications for tax
exemption) and can cost $555 or more in filing fees, not including any professional fees for an
attorney or accountant.
*These steps illustrate the process in California. Incorporation process may differ in other states.
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3
3
Resources
Publications
Attorney General, State of California. Attorney General’s Guide for
Charities. San Francisco, CA: California Department of Justice, 1998.
Free.
This guide provides information on California and federal laws that govern
nonprofit organization, defines the steps to apply for tax-exempt status,
and lists additional services and publications.
Internet: http://caag.state.ca.us
Write: Office of the Attorney General, Public Inquiry Unit, PO Box
944255, Sacramento, CA 94244-2550
Internal Revenue Service. Publication 557-Tax-Exempt Status for
Your Organization. Washington, DC: Internal Revenue Service, 1997.
Free.
This publication discusses the rules and procedures for applying for
exemption from federal income tax, filing requirements, and required
disclosures.
Internet: www.irs.gov
Telephone: Your local IRS office.
Mancuso, Anthony. How to Form a Nonprofit Corporation in
California, 10th ed., Berkeley, CA: Nolo Press, 1998.
This handbook explains the legal and practical implications of incorporating
a nonprofit organization. It includes California-specific legal and tax
requirements and step-by-step instructions and tear-out forms and a
CD-ROM with forms for applying for tax exemption, articles of
incorporation, sample bylaws, and minutes. Nolo also publishes The
California Nonprofit Corporation Kit that includes a binder in which to
organize corporate records.
Internet: www.nolo.com
Telephone: 800-992-6656
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Internet resources
Internal Revenue Service
http://www.irs.gov
Internet Nonprofit Center
www.nonprofit-info.org
The IRS website provides answers to frequently asked questions about
tax-exempt organizations. The site provides a step-by-step review of what
an organization needs to know to file for tax-exempt status, whether they
are eligible to receive tax-deductible charitable contributions and annual
filing requirements for tax-exempt organizations. Publication 557 and
other federal forms for nonprofit organizations can be downloaded directly
from the site.
The Internet Nonprofit Center offers information for and about nonprofit
organizations. Searching on the keyword “start-up” in the Nonprofit FAQ
section of the site will direct users to information about how to start a
nonprofit. The information includes how to incorporate an organization,
the type of legal help needed and estimates on legal fees, setting up
foundations, and obtaining a bulk mail permit. The site also offers advice
on how to operate the organization before it is incorporated and how to
create a budget for IRS Form1023 Exemption Application.
The Nonprofit Genie
www.genie.org
The Genie is a project of the California Management Assistance
Partnership. This site gives you:
• Answers to your questions about fundraising, boards, financial
management, and much more.
• Opinions from grantmakers, management experts, and nonprofit
leaders.
• Links to the best nonprofit Web sites.
The Foundation Center
http://fdncenter.org
The Foundation Center Web site identifies a number of useful resources
for start-up nonprofit organizations. It points users to web resources and
recommended books specific to those wanting to incorporate a nonprofit
organization. It also provides general information that may be useful
including user aides for specific types of charitable organizations and
information on special events, fundraisers, and proposal writing.
Organizations
California Management Assistance Partnership (C-MAP)
http://www.c-map.org
C-MAP, the California Management Assistance Partnership, is a consortium
of 15 regional, nonprofit support organizations providing training and
technical assistance to local nonprofits. Each of these organizations
provides workshops in nonprofit management and fundraising and
information and referral to local community resources. Some partners also
offer computer workshops, provide consulting services, host conferences
and other events, and publish books and informational materials.
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